THE Bank Indonesia (BI) board of governors meeting on April 23 to April 24 decided to raise the benchmark interest rate (BI Rate) by 25 basis points to 6.25%, breaking through the 6% rate that had been maintained for six months since October 2023 to reach the highest level since April 2015.

Raising the central bank’s benchmark interest rate was not a popular decision, but the monetary measure was an appropriate action for two reasons.

First, it was made in response to a global turmoil that has turned out to be increasingly uncertain, from the Federal Reserve’s delay in accelerating the reduction of its benchmark interest rate in line with US inflation, which is still above the targeted 2% (higher for longer), and to geopolitical factors such as Russia’s unending war on Ukraine, which has been exacerbated by the escalation of war between Israel and Gaza in the Middle East to involve Iran.

As is always the case, an emergence of global turmoil will move funds from emerging countries to safe-haven assets, especially US dollars (flight to quality).

Big and institutional portfolio investors are worried about their funds. As a result, the US dollar exchange rate has predictably strengthened against many other countries’ currencies, including the rupiah, which even exceeded 16,000 rupiah per US dollar last week.

The second reason is to anchor future inflation within BI’s corridor of 2.5 plus or minus 1% in 2024 and 2025. There appears to be stronger inflationary pressure in the future, especially from food inflation, which will cause inflation to continue rising this year.

The policy to raise the benchmark interest rate shows that BI remains consistent with its pro-stability policy in navigating the economy.

Various responses have certainly arisen from those who agree and disagree with this measure. It is indeed a dilemmatic decision.

On the one hand, it will stabilise the rupiah’s value against both the US dollar (exchange rate) and goods and services (inflation), but on the other hand, a higher benchmark interest rate will boost the cost of funds so locan interest rates will be higher. In the end, loan disbursement will falter and threaten economic growth.

However, the central bank included this unpleasant effect in its calculations when issuing its latest decision to increase the BI Rate. The central bank did not deny the impact, so it therefore also provided a sweet jamu (herbal medicine) in the form of macroprudential liquidity incentives to the banking industry. These are all part of the BI policy mix that has been a mainstay so far.

The Macroprudential Liquidity Policy, which provides incentives in the form of eased reserve requirements by a maximum of 4%, was issued in October 2023.

The banking industry has since enjoyed an abundance of liquidity from BI, which is why the additional liquidity encouraged credit growth to 12.40% up to March 2024.However, in observing the various current conditions, BI has expanded the scope of priority sectors that can obtain the liquidity incentives, such as supporting downstream sectors, construction and productive real estate, the creative economy and automotive.

 - ANN